Economics of Water Use: Issues for Allocation
Simon Harris
Harris Consulting
This paper discusses water use in the context of allocation. It outlines the research underway in these areas, and potential avenues for resolution of difficult conflicts.
Water allocation occurs at many levels and in many different ways. In this paper I will address four levels of question:
- How much water should be available for abstraction
- How much of the available water should be allocated?
- To whom should the water be given?
- How should individuals use the water?
This include questions such as the highest return for each unit of water, and the efficiency with which it is applied. These questions, which are particularly vexing from an economists point of view because they incorporate a range of tangible and intangible factors, economic, social and physical constraints, and some complex relationships between hydrology, irrigation infrastructure, and land uses.
How much water should be available for abstraction?
The RMA and previous practice under the Soil and Water legislation has led to a de facto regime of minimum flow with levels of abstraction above these. The perception that there is an environmental bottom line (river flow or aquifer level/pressure) below which the instream values will be protected is a simplistic representation of reality. As abstraction increases there is increasing risk to instream values, as shown stylistically in Figure 1. Even if there is no abstraction there is still a risk of ecosystem decline in dry years. Conversely, many of our river ecosystems are resilient to periods of no flow. Given this continuum, science cannot provide a single "safe" level making the setting of a standard extremely difficult. Determining the appropriate level of risk is a socio-political decision that requires a judgement call between instream and abstractive demands on the water. This requires information on all instream and out of stream values.
When we look at the extreme end of the irrigation possibilities calculated by Smith, Harris and Morgan (2002)4, the outer limit is approximately $6 billion in GDP and 70,000 FTEs. This is certainly a substantial increase in the economy, but is it sufficient to warrant the in stream and out of stream environmental costs this would entail? My view is that we will need to focus on those resources where the greatest gains can be made at least cost. This will require sacrificing development in some rivers and moving further along the risk/return continuum on some others. We should be presenting not only the economic, environmental and social implications of development on one river, but also what the same level of economic output would cost on other rivers and resources.
How much water do we allocate
While the question of how much water is allocated given a minimum flow has environmental dimensions, its primary importance is in relation to the reliability of the resource to users. The higher the allocation, the less often the river has enough water to satisfy the allocation, and therefore the less reliable the flow is. The less reliable irrigation becomes, the less viable more intensive land uses become, and at some point the returns from increasing the number of farmers who have irrigation will be offset by those farmers adopting lower output land uses. Costs of lower reliability have a number of dimensions beyond the simple loss of income in times of restriction. They will include the costs of managing a system to cope with unreliable water supply (system costs) and investment decision costs regarding suitable land uses and capital intensity for a given reliability of supply.
Research is currently underway5 attempting to model the interactions between allocation, the impacts of cuts to farm operations, and the implications of this for viable land use. This will seek to provide information to decision makers about the level at which regional returns are optimised, and what the implications are for individual irrigators. This as a fruitful area of research in the future, and one in which I hope we are able to simplify some of the many relationships involved here to identify the key issues for decisionmakers to focus on.
To whom do we allocate water
I see two means of water allocation - through a market instrument or some planning based approach (including the current first come first served).
Market instruments involve the creation of an "opportunity cost" or value for the water itself, independent of its current use. Currently once a resource consent is obtained the only cost associated with water is in getting it to the property and applying it. While these costs may be considerable, they don't apply a value to the resource itself. Without opportunity cost, users have little incentive to direct the water to high value uses, apply water efficiently, or even to see that their water right is used when the resource is scarce.
Markets in water rights are often touted as the solution to this problem - once the market is established rights holders will see the value of their rights, and this will encourage water to be applied more efficiently, and to be directed to the highest value uses.
Whilst I agree with the theory of this, the practicalities of water markets will often intrude. I was recently involved in a study with Lincoln Environmental on water markets and transfers, and in this we identified a range of practical and attitudinal barriers to water transfer6. Some of these barriers can be overcome but others, such as the physical limitations on catchments and delivery systems, cannot. As a result, in many places the opportunities for rights holders to trade will always be limited. This limited opportunity to trade creates an illiquid market in which buyers and sellers find a market price hard to determine, and where sellers place a high premium on the water for fear of not being able to repurchase a water right in future should they need it. Our study concluded that water markets can and do operate successfully, they are limited in extent and are unlikely to present an entire solution to addressing inefficiencies in water management.
There are other opportunities for creating an opportunity cost for water - such as the tendering out of water rights or setting of charges for water. This would create an opportunity cost for the water even where opportunities to trade were limited, and thereby encourage users to use water more efficiently and to request only as much as they need. However charging for water would require a major cultural shift in New Zealand. There is considerable opposition to charging for what has traditionally been a free good, both within the farming community and among the population in general, with an underlying fear that charging equates with loss of control, big business monopolising resources, and loss of long held rights to use water.
My own view is that in the long run a charging regime will make water rights more secure for the primary sector rather than less secure. By becoming a source of income, rather than a political, environmental and economic cost, the use of water for irrigation will be viewed much more positively. One could perhaps envisage some of the water use charges being diverted to offsetting environmental works, so the fishing and conservation movements are able to make trade offs in terms of allocation of the resource rather than the current "win-lose" scenario. It is clear however that the social, cultural and even technical barriers to achieving this are significant, and water charges are a long term area of investigation for the policy community rather than an overnight change.
Water Use on Farm
Water use on farm provides substantial returns. It has been estimated that in east coast regions irrigation can increase returns by $1800/ha after accounting for capital costs7. MAF has funded considerable research on water use efficiency which show gains to be made from improving measures such as application technology and scheduling8.
However achieving increased efficiency from available water poses a continued problem for policy makers at the national and regional level. It is first of all important to differentiate between technical efficiency and economic efficiency. Technical efficiency, is often taken to mean the physical efficiency with which available water is applied to the root zone of the target crop, and very high levels of efficiency can now be achieved with low application spray systems.
Whilst technical efficiency is useful, from an economic point of view we need to look at the overall efficiency of the water use on farm. For example currently farmers look at the cost of application, and compare it with the returns they receive from moving to a more efficient application method. For those with established application systems it is rarely worth moving to a more efficient system without a change in land use.
Regional councils have attempted to manage efficiency through "reasonable use" guidelines, which specify the amount of water allowed in a resource consent for specified land uses, and in some cases on different soil types and climatic zones. This administrative approach to managing efficiency on farm has significant difficulties, not the least of which is monitoring the system and managing land use change. This approach is really only a proxy for an opportunity cost associated with water, and again points to the need for a charging or tendering regime to be associated with resource consents for water.
Summary
The key economic issues in water allocation across the spectrum are:
- The national and regional objectives for our water resources need to be clearly defined
- We need to use a mix of planning, market and quasi market approaches for dealing with allocation problems
- In order to do this we need to tackle the difficult issues of opportunity cost, strategic planning
- When making these decision we need to focus on resources where greatest gains possible, and to look across a range of resources in making decisions about how to use each one.
- We need to decide whether the institutional mixes are right for achieving our objectives.
Contact for Enquiries
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